When financial instruments, such as those listed in Table 1, are traded, the credit worthiness of the opposing counterparty is important because obligations of one or both parties under such financial instruments may extend up to and beyond thirty years. Each of the parties may be exposed to risk based upon the ability of a counterparty to fulfill its obligations. The resulting credit exposure over the life of a contract is potentially an unknown amount. Therefore, trading parties have a significant interest in limiting credit exposure.
In a typical “conversational” trading desk scenario in which traders enter and act on orders over the telephone, a credit officer for each trading entity assigns credit lines for each potential counterparty. An intermediary broker is used to match bids and offers between various parties. Once two parties are matched, credit officers for both parties then determine whether to approve the transaction based on the opposing party's credit limit. Alternatively, the broker may maintain a list of which entities each party is willing to trade with, and only match parties who are cleared to deal with one another.
TABLE 1F/X ProductsAmerican and European OptionsCallsPutsRisk Reversals and StraddlesStranglesExotic OptionsKnock-ins/outsReverse knock ins/outsOther InstrumentsForwardsFixed Incom ProductsSwapsSwap spreads (traded with treasury hedge)All-in rate swapsSpread switchesAll-in-rate switches1–3,3–6,1–6 month LIBOR basis swapsCP-3 month LIBOR basis swapsForward Rate Agreements1/3/6 month LIBORFRA SwitchesSwaptionsEuropean (payer, receiver, straddle)Bermudan (payer, receiver, straddle)Bermudan-European Switches (payer, receiver, straddle)LIBOR Cap/Floor, StraddleLIBOR Digital Cap/FloorConvexity ProductsCap/Floor, Straddle (CMS/CMT 2, 5, 10, 30 year tenors)Rolling Spread Locks against a spot hedgeRolling Spread Locks quoted outrightEquity Index ProductsAmerican and European OptionsCallsPutsStraddles
A number of systems have been developed which attempt to automate the trading process and provide credit controls. For example, U.S. Pat. No. 6,014,627 describes an anonymous trading system which identifies the best bids and offers from those counterparties with which each party is eligible to trade. The system pre-screens each bid and offer for a particular type of financial instrument for compatibility with credit information to calculate a best price (the “dealable” price), for each entity dealing with the particular financial instrument.
U.S. Pat. No. 5,924,083 describes a distributed trading system for displaying a credit-filtered view of markets for financial instruments based upon credit limits entered by the trading parties. Each trading entity initially enters credit information which consists of the amount of credit that the trading entity is willing to extend to other trading entities for one or more types of trading instruments. Each trading entity may also create group credit limits by which the trading entity may limit the amount of credit it is willing to extend to a group of potential counterparties.
PCT Application, No. PCT/US98/21518 describes a credit preference method in an anonymous trading system for screening trades between entities. Three screening methods are described: a binary method in which each entity makes a yes or no determination as to whether or not it will deal with each potential counterparty; a line binary or time limit method in which each entity sets a maximum maturity of contracts for each potential counterparty; and a “complex” method in which each entity specifies a maximum amount it will trade with each counterparty for one or more “maturity bands.” The system provides a “complex preference interface” through which a credit administrator for the trading entity can specify for each potential counterparty, the maximum exposure for each maturity band. For example, an entity could specify that for a given counterparty, it “will do up to $100 million out for 5 years, and then only $50 million out from thereafter out to 10 years, and nothing thereafter.” In determining appropriate limits, the administrator use a measure of “risk equivalence” (RQ) which is calculated as a function of the potential exposure averaged over a series of time points, weighed by a discount factor.
Although the above systems disclose credit mechanisms for use with trading systems, no known prior art allows an administrator or other authorized user to easily relate credit limits for multiple tenors or instruments. Thus, there exists a need for a method and system of facilitating the use of related credit limits for use with trading systems.